For readers who may not yet have read IRS Revenue Ruling 2023-2, here is a link. Click here. In short, the IRS ruled that property in a completed-gift irrevocable trust will not get a stepped-up cost basis for income tax purposes at the time of the trust grantor’s death. My impression is that some business news services have been reporting this IRS ruling too broadly to convey a notion simply that there can be no stepped-up cost basis for property in an irrevocable trust. Therefore, the following points might be helpful for anyone digesting Rev. Rul. 2023-2:
One. I believe a death FMV stepped-up basis still applies for property in an incomplete-gift irrevocable trust, unchanged by this IRS ruling. To that end, I read Rev. Rul. 2023-2 as applying only in a narrower situation where the trust property at issue (owned within the trust) was a completed gift transfer to the trust, coupled with the trust agreement having certain income tax provisions that make the trust “defective” for income tax purposes. In everyday terms, this intentionally “defective” trust itself is not subject to its own income tax, but rather the person (the trust “grantor”) who transfers the property into the trust continues to be taxable on the trust income, gains, etc. All reported on the grantor’s own personal income tax return Form 1040;
Two. The primary impact of Rev. Rul. 2023-2 targets “sales to defective grantor trusts” with an irrevocable trust / completed-gift design. In other words, this “sale” to the trust is reported on a gift tax return Form 709 as a completed transaction, typically as part of a partial gift or “non-sale” gift transaction. Essentially, and for example, the grantor sells to this “defective grantor trust” the grantor’s property with a current FMV of $500,000, with the grantor taking back a note from the trust for $500,000. This “sale” transaction is reported on the gift tax return Form 709. The trust pays the debt service to the grantor on the $500,000 note.
Here is the kicker for this point Two. When the grantor thereafter dies, some (a minority in my view) tax practitioners believe there is a supportable argument that the trust property at the time of the grantor’s death should get a (date of death) FMV stepped-up cost basis under the estate tax rules, but also without that FMV property being included in the value of the grantor’s estate for estate tax purposes. This FMV stepped-up cost basis result does apply, generally without issue, to property owned by an individual at his or her death when included in the value of that individual’s estate for estate tax purposes. But, here this “defective trust” owns the property at the grantor’s death.
Assume, in the above example, the trust property increases (within the trust) from its $500,000 purchase value to $2.0 million FMV at the grantor’s later death. The above practitioners believe the trust property gets a death FMV stepped-up basis to this $2.0 million FMV, with no inclusion of this $2.0 million value in the grantor’s estate for purposes of computing estate tax. Keep in mind the basis of the property in the hands of the trust is $500,000 in this example at the time of the grantor’s death. The above IRS ruling takes the position there is no death FMV stepped-up basis; therefore, the trust property continues after the death of the grantor with its unchanged $500,000 cost basis;
Three. I purposely am not including in this blog post my own deeper view as to Rev. Rul. 2023-2. But keep in mind the trust owns the property at the grantor’s death, not the grantor. This trust ownership point, in my general view. creates the steepest slope in this debate. The arguments on both sides of this question also are densely complex, well beyond my simple blog post here; and
Four. My broader, general reaction to Rev. Rul. 2023-2 is that there possibly may be remedial options available in some instances to address a response to this ruling. I do not believe lawyers typically read any pronouncement or rulings without sensing an immediate faint glint of potentially remedial possibilities.
James M. Kane Legal Blog 